Archive for March 18th, 2008

I have added another paper to my website on the need for financial inclusion and it focuses on India. The paper puts forth a couple of ideas:

Use behavioral economics/finance,

Address social issues

Real-sector inclusion is as important

I have written a lot about behavioral finance and even pointed a paper which looks at using BF to enhance financial inclusion.

As far as the other two points are concerned, I found some material which confirms my belief.

This speech from Prof Yunus shows how Grameen Bank addressed various social issues. He shows how he convinced more women to take micro-credit in what was otherwise a male dominated bastion. Without addressing these issues, this revolution would not have succeeded. As we see very similar conditions in India, we need to understand these issues in detail.

I came across this article from James Surowiecki where he says just providing finance is not enough. If we provide microfinance we expect them to open some small business from the finance. As not all people are entrepreneurs and most actually work for someone else, the problem doesn’t end.

The author goes a step further and advocates the need to promote small and medium enterprises which will employ people.

In any successful economy most people aren’t entrepreneurs—they make a living by working for someone else. Just fourteen per cent of Americans, for instance, are running (or trying to run) their own business. That percentage is much higher in developing countries—in Peru, it’s almost forty per cent. That’s not because Peruvians are more entrepreneurial. It’s because they don’t have other options.

They need more small-to-medium-sized enterprises, the kind that are bigger than a fruit stand but smaller than a Fortune 1000 corporation. In high-income countries, these companies create more than sixty per cent of all jobs, but in the developing world they’re relatively rare.

Like this:

I know in these times it may not be the right question to ask. The share prices seem to be changing due to any news for instance, Bear Stearns had little to do with India but markets have crashed.

Coming back to some fundamentals, we know share prices are equal to the discounted value of future cash flows. So, it is mainly two things- cashflows and discount rate.

I came across this excellent speech from John Cochrane (of Chicago University). The main idea is:

In the early days, the “expected” part took center stage: Researchers focused on the “efficient” incorporation of information into prices. Since the early 1980s, however, our focus has been much more on the “discounted” part.

What led to this shift – the research which discovered anomalies didn’t correct as per expectations.

Empirical discoveries forced this shift. Pretty much any time we see information, we find that it is quickly reflected in market prices. But prices also move a lot (over time and across securities) when there is no cashflow information. Every expected-return anomaly turns out to correspond to a source of common movement. Even the momentum stocks rise or fall together. These are just the sort of observations that suggest variation in discount rates, i.e. expected returns, or risk premia.

So it is discount rate that changes often leading to the changes in share prices. The share prices change as everyone has his own discount rate which in turn is is influenced by many factors like overall market conditions, personality (high or low risk averse), job profile (if he is an equity analyst/follower), mental conditions (happy/sad/stressed) etc.

This is also in line with findings of behavioral finance. I doubt whether Cochrane advocates BF. Though with Richard Thaler at Chicago, the effect seems to be happening.